Over the past 40 years, I have spent a considerable amount of time studying tax policy. Therefore, I may have a different perspective than most on President Trump’s recent tax proposals.
Both President Trump and House Speaker Ryan are trying to portray current tax proposals as an extension of Reaganomics. Neither is being fair to President Reagan.
During the eight years of the Reagan Presidency, five major acts were enacted involving taxes. The Economic Recovery Tax Act of 1981 was the only tax cut.
Tax increases were enacted in 1982, 1984 and 1988. Major tax reform, which was scored as being revenue neutral, was enacted in 1986.
The 1986 Tax Reform Act revolutionized how tax was calculated, and it made the federal individual income tax system more progressive.
Prior to 1986, the stated income tax rates were as high as 70 percent. But in reality, nobody paid tax at those rates.
The rich invested in tax shelters, which eliminated their tax. Back in the days of Jimmy Carter, you could invest $10,000 in a tax shelter that would give you $50,000 of write-offs.
For someone in the 70 percent tax bracket, that translated into a $35,000 tax savings. It did not matter how the underlying investment performed; the tax savings alone made the investment worthwhile.
The 1986 Act made significant changes to the computation of taxable income (i.e., the amount on which tax is computed). Income subject to tax was accelerated and deductions were either deferred or eliminated. It was no longer possible to invest in tax shelters.
In exchange for those changes the rates were dropped. Today Democrats disingenuously harp on the rate cuts while ignoring the computational changes that broadened the tax base.
Because of the 1986 changes to the tax law, most upper middle class people now pay 35 percent to 40 percent of an amount approximating their economic income. Before 1986, they often paid 70 percent of zero because they were able to reduce their taxable income to amounts significantly below their economic income.
Another hallmark of the 1986 changes was that all types of income were taxed equally so that the marketplace would ensure that investments resulted in the greatest productivity.
Consequently, invested capital shifted from tax shelters to other, more productive segments of the economy. The economic boom of the Clinton years likely would not have occurred without the 1986 tax reform.
Last summer House Speaker Ryan unveiled the Republicans’ tax plan, which that party called “A Better Way.”
President Trump has incorporated variations of these proposals. Both Trump and Ryan proposals differ significantly from those that President Reagan envisioned.
First, their proposals are not revenue neutral. In order fund his proposed tax cuts, Speaker Ryan suggested the implementation of a new consumption-based tax.
Furthermore, unlike 1986, the beneficiaries of tax rate reductions generally are not the same people who are adversely affected by the computational changes proposed.
Finally, different types of income are taxed at different rates. As someone who has prepared tax returns for more than 40 years, I am confident that the proposed legislation will add even more complexity, in spite of the simplicity that is promised.
Although I am retired, I still prepare a number of returns for friends and family. This year, after I completed those returns, I prepared a “back of the envelope” spreadsheet analysis attempting to estimate the impact of the legislative proposals on these taxpayers.
About 2/3 would pay more tax, principally because of the elimination of itemized deductions and the deduction for interest incurred in a trade or business.
I then created a fictitious return based upon a composite of several of my wealthy former clients. Not surprisingly, this composite taxpayer paid a lot less tax under the proposals.
Obviously, my endeavor is not scientifically based and we don’t know the precise provisions of what Congress will ultimately pass. But this exercise did reinforce my perceptions that the current proposals bear little resemblance to Reaganomics.
To be fair, the Republican proposals contain some good provisions, like repealing the alternative minimum tax which adversely affects middle class taxpayers.
But on balance they seem to shift the tax burden from corporations and the wealthy to the middle class without achieving substantive simplification.
A colleague of mine who works inside the Beltway as a tax legislative analyst told me not to worry. He put his analysis into a perspective that all Dodgers fans can understand.
He handicapped the chances of the Trump proposal being enacted as being significantly less than the chances of Tommy Lasorda stopping in an Italian restaurant and deciding not to order his favorite pasta dish.
Jim de Bree is a retired CPA who resides in Valencia.